The banks and other mortgage lenders have been challenged to better understand the ability of customers to repay their loans as the prudential regulator opens a new front on loan affordability.

The Australian Prudential Regulation Authority has written to banks on the subject and bank auditors have told the Weekend Financial Review they are in the process of discussions with APRA to “scope" the investigation.

The revelation came on Friday as
ANZ
Banking Group became the final bank to withhold part of the Reserve Bank’s 50 basis points rate cut this month.

ANZ passed through 0.37 of a percentage point cut to home loan and small business borrowers, noting that high rates paid to its 2.9 million depositors continued to put pressure on funding costs.

Separate research by UBS showed banks that grew mortgage lending faster over recent months, notably ANZ and National Australia Bank, suffered the biggest hit to profits because of elevated funding costs.

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UBS analyst Jonathan Mott warned that bank investors should not expect the trend of rising dividends to continue, noting that it would not require much of a pick up in bad debts for dividends to come under pressure.

In a speech on Friday to the American Chamber of Commerce, APRA chairman John Laker said the external auditors of authorised deposit taking institutions (ADIs) had been “enlisted to our cause through our targeted review".

“The topic of the targeted review is housing loan approval standards, focusing on the income tests that ADIs use to assess whether borrowers can afford the interest and principal repayments on their loans," Dr Laker said in Melbourne.

“Loan serviceability criteria, as they are called, are a critical part of the approval process: weaknesses in serviceability policies can quickly lead to increases in the volume of loans defaulting in an economic downturn.

“In Australia, the very high proportion of variable rate housing lending means that housing credit quality is more sensitive to changes in interest rates than in many other jurisdictions. Further, debt interest payments as a proportion of disposable income, though falling recently, remain quite elevated compared with the experience of earlier decades."

APRA’s targeted review requires external auditors to assess the strengths and weaknesses of the serviceability criteria used for housing loan approvals, including the popular serviceability “calculators" used by lenders, which are often on websites.

Speaking to the Weekend Financial Review later, Dr Laker said APRA chose the targeted reviews to reflect live issues. Last year’s review of collateral and foreclosure management, while it sounded dry, followed the huge problems in the US in the aftermath of the financial crisis when the actual ownership of mortgages was unclear.

“These are bread and butter issues for supervisors but they are critical," he said.

In the speech, he also reiterated earlier warnings that cost cutting by banks must not affect risk assessment roles and that expansion into Asia, such as that by ANZ, must proceed with caution.